Case

U.S. Subprime Mortgage Crisis

 Case 2: U.S. Subprime Mortgage Crisis
Background: This case study focuses on U.S. subprime mortgage crisis. The Case
follows collapse of the subprime home mortgage crisis in the United States in the
year 2008-09, which added to the U.S. financial crisis Judge found that the
mortgage crisis was caused by a lack of confidence in the ability of subprime
borrowers to renegotiate their home loans. The court ordered in favor of the
borrowers who couldn't pay the high regularly scheduled installments and started
to default. The U.K. court ruled that the loan default was due to a breach of
contract. The portion of subprime home loans to add up to beginnings expanded
from 9% in 1996 to 20% in 2006.

Representing around one-fifth of the U.S. home credit market subprime contracts
totaled $600 billion out of 2006. More awful behaviors took off as adaptable fee
contracts reset at better boost charges. Securities upheld with contracts, containing
subprime contracts, misplaced a big little bit of their fee which had been drastically
held via way of means of cash associated corporations generally. Overall economic
specialists further faded acquiring of domestic credit score moved dedication as
part of the lessening withinside the cutoff and power of the non-public cash
associated device to assist advancing. Stresses over the adequacy of U.S. credit
score and cash associated commercial activities provoked solving credit score a far
way and leads to financial improvement in U.S. moreover, Europe.

There are several features of the subprime mortgage crisis in the time frame
indicated by the CBB hypothesis. However, as with other crises, certain
characteristics are relevant to this crisis, for example, assets have been transferred
from balance sheets, banks to markets, opaque and complex assets have been
created, Failure to properly assess the risk of these assets by companies. The
subprime mortgage meltdown passed off when banks offered huge number of
mortgages-based loans to satisfy the demand for subsidized mortgage-based
securities offered through the secondary market. When domestic charges fell in
2006, it triggered repayment defaults. The risk extends to mutual funds, pension
funds and agencies that hold these derivatives. This resulting into 2007 banking
crisis and the 2008 currency crisis produced the worst recession as the Great
Depression.

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Critical issues and challenges
1.Regulatory issues with Banks and other financial institutions

There was not enough supervision of the banking market. Banks had the freedom
to act according to their needs since the 1980s with a lot of deregulation. At the
same time, the State has not kept the financial strategies that it has put in place and
with the tendency to globalization. Regulatory completion in the United States has
not been up to par, compared to other countries around the world. Subsequently,
the banks neglected their fundamental responsibilities and engaged in massive
collusion. There has also been a failure on the part of lawmakers to formulate
regulations that could have restricted them from doing so.

2.Investor Due Diligence:

Investor due diligence is a vital factor in a green market and IOSCO has published
quality standards and practices designed to beautify traders' abilities to make
informed funding selections through better disclosure. statistics applied using
securities trading instruments in secondary markets Concerning collective funding
schemes and traders, the regulators of securities and exchanges regularly mandate
a positive disclosure degree to account for the retail investor. By contrast,
withinside the non-public markets on which many established finance
merchandises are sold, the diploma of disclosure is personally negotiated with the
aid of using the massive institutional traders, the goods are built (i.e., funding
banks, pension and mutual funds, hedge funds, and different institutions) and the
issuers & originators. However, despite so many differences between the titles
provided in the public and personal markets, it seems that this is a minimal related
anecdote, there may be a small distinction between the extent of the disclosure
provided with the help subscribers and initiators in non-public and public markets

3.Transparency in the Secondary Market:

Structured financial securities listed on a stock exchange under a regulatory system

that requires disclosure of the aforementioned recording styles have generally
suffered a liquidity disaster affecting the retail markets. At the same time, some of
these elements may arise from the disclosure regulations of the originator or the
issuer. In general, public secondary markets also tend to be more liquid than
personal markets, as, among other things, the range of capabilities of consumers
tends to be wider and the buying and selling of records tends to be greater. be more

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transparent. By contrast, dependent finance transactions regularly contain
securities and funding automobiles, which can be authentic merchandise traded
amongst a small range of institutional investors. Subsequently, the methods of
defining commissions for these products are often not as advanced as debt
securities and gadgets traded on a public market or perhaps on an over-the-counter
(OTC) market with the public reporting requirements.

Case Analysis

The financial crisis of the late 2000s did not have a single source. Instead, the
economic downturn was due to operations in the finance, credit and real estate
industries. The main culprits, however, were mortgage-backed securities,
collateralized debt obligation (CDO), and the adjustable escalation in mortgage
interest rates on senior and subprime loans.After the housing bubble burst, the
general Dodd Frank rule was introduced, which included the Mortgage Law and
the Consumer Financial Security Law. It almost more than a decade has passed
since the implementation of these major changes, mortgage lending practices have
changed to adhere to new practices imposed by law. The 2008 financial crisis
shook the financial sector in the United States and the markets of various states in
various parts of the world. It erupted in 2007 and triggered a credit crunch and an
economic recession in European countries in the second half of 2008. The causes
of the crisis lie in subprime loans, borrowers and the injection into the financial
system of a large number of securities funded by these mortgages.

For more people, economic stability and development have created opportunities to
afford housing. Until 2006, the residential real estate market was booming, real
estate values continued to rise and mortgage rates continued to fall. Subprime
borrowers have become a new level of consumers. credit history, poor wages or
seasonal work, recent bankruptcy filings, and other features that have kept them
from getting a mortgage in the past. Lenders have noticed that house prices are
rising and families can easily refinance their loans. And the more loans are made,
the more money the lender receives. Purchasing of a house was so easy more
people are taking that people who are generally unable to take out a loan could
afford a mortgage under new circumstances. The deposit didn't need to be large
and for the first 2-3 years the banks lured them in by offering low interest rates.
Subsequently, under new conditions, the purchased property would be refinanced,
and consumers would make new modified monthly mortgage payments.

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As the monthly payments are manageable, investors participating in the
transactions could be expected to meet their initial loan commitments. However,
the probability of default becomes high after debt financing and a rise in mortgage
rates that have been adjustable. To mitigate the risk of subprime mortgages, credit
companies have agreed to spread the risk over hundreds of institutional investors.
Financial institutions and the securitization process were then used to finance
subprime mortgages. The global crisis has affected a large part of the population of
the United States and the United Kingdom. First, in the near future, millions of
homeowner’s risk losing their property because credit conditions are tight,
refinancing their homes is difficult, unemployment is on the rise as more people
lose their jobs and business confidence remains low. Second, as default rates rise,
pension funds and hedge funds that have acquired covered bonds containing
subprime mortgages as underlying assets have suffered losses. This has adverse
result and many more people are taking risks to lose retirement funds. Third, in a
number of countries, including the United States and the United Kingdom,
subprime mortgages have triggered economic downturns. The decline in gross
domestic product reduces overall national income and the income levels of many
households in particular. Moneylenders took more risks as the rising number of
subprime credits because of rising land esteems. A few scholars accept that Wall
Street energized this sort of conduct by packaging the advances into protections
that were offered to annuity reserves and other institutional financial specialists in
search of more significant yields.

Falling land prices and the massive default on home loans have crushed Lehman
Brothers, one of the world's largest investment banks. They had to shut down their
subprime loan specialists and despite their many efforts to stop the dying (for
example, by giving away shares) they continued to face woes until, on September
15, 2008, Lehman Brothers demanded liquidation. Lehman Brothers drop into
liquidation was a major reason for the 2008 financial exchange crash. Three of the
major US speculative banks either collapsed (Lehman Brothers) or were sold to
other banks threatened with bankruptcy in 2008. In the global monetary system,
these disappointments increased insecurity. The surplus of two venture banks
chosen to become investment banks, Morgan Stanley and Goldman Sachs, has
finally come under closer scrutiny. In the years which paved the way for the
emergency, some have taken measures to limit the guide applicable to banking
organizations. By comparison, the major risk banks that imploded during the
emergency were not relying on guidelines from the safe banks.
The SEC (Securities and Exchange Commission) and Alan Greenspan expressed
their dissatisfaction with the authorization of autonomous risk banks in their
statement to Congress. As demonstrated by the Urban Institute, this bihardliner

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amendment was suggested to increase the number of advanced products that have
lowered the direct spending front for borrowers in order to make home ownership
more affordable. Among the latest forms of mortgage credit granted and which
became famous in the mid-1980s are adjustable interest, floating rate preference,
rising costs, and just home loan premiums. The use of adjustable rate mortgages
has resulted in systematic mistreatment of wild loans. Variable rate mortgages
accounted for almost 90 percent of subprime contracts awarded in 2006. The
government took several measures to mitigate the damage. In the place ofActively
pursuing foreclosure, a group of actions aims to allow lenders to rework
commissions and other distressed mortgage arrangements or to refinance
“underwater” mortgages (loans that exceed the market value of homes). This has
minimized foreclosures which could further weaken house prices due to
subsequent sales. Congress approved temporary tax credits for homebuyers that
increased demand for housing and dampened the decline in house prices in 2009
and 2010. Congress significantly increased the overall amount of mortgages that
will be backed by the FHA to support mortgage financing. From 10 percent to over
40 percent because FHA loans pay low installments. The Federal Reserve is
committed to buying long-term securities until the labor market improves
significantly and keeping short-term interest rates on lower side until
unemployment levels have fallen, in order to continue lowering interest rates and
fostering the optimism necessary for economic growth, as long as inflation remains
low (Bernanke 2013; Yellen 2013). and other housing policy actions helped
improve real estate markets by 2012 (Duca 2014). At this point, national house and
housing prices started to rise, housebuilding went from lows and foreclosures.
Open market activities were carried out by the Central Bank to ensure access of
assets to party banks. Federal Reserve Chairman Ben Bernanke announced a cut in
interest rates. On February 22, 2008, key rates fell to 3.5%, the largest drop since
1984. Another 50 point cut was made in January 2008. The rating cycle followed
by the FICO credit agencies should be rethought and enhanced to promote greater
transparency of the risk associated with Unpredictable Mortgage Backed Securities
and the entities that offer them. lending practices, payment strategies, credit
counseling, etc. should be taken care of by the moneylenders and controllers.

MACROECONOMIC THEORIES AND TOOLS

1.Monetary Policy

Monetary policy is a set of tools available to a country's central bank to attain

sustainable growth of economy by controlling the overall supply of money
available to the country's banks, its consumers, and its businesses. The goal is to

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keep the economy at a pace that is neither too hot nor too cold. The central bank
may impose an increase in interest rates on loans to discourage spending or lower
interest rates to attract more borrowing and spending. Many professionals have
blamed the US mortgage disaster on expansive financial coverage throughout the
early 2000s that kept hobby prices low for goodbye, despite rising asset prices.

2.Fiscal policy

Fiscal policy is the means by which any government regulates its spending levels
and tax rates to monitor and influence a country's economy. It is the related
strategy of monetary policy by which a central bank influences the money supply
of a country. These two policies are mainly used in various combinations to guide
a country's economic goals. Here's an overview of how fiscal policy works, how it
should be monitored, and how its implementation can affect different people in an
economy.
Some Specialist proposed to accompany monetary expansion with Fiscal stimulus.
Former treasury secretary Lawrence Summers argued that fiscal policies would be
felt by families bearings the brunt of the recession, contrary to monetary policy
that had a more direct impact on financial institution. The Bush administrations
$150 billion package included tax rebates for households and individuals and tax
cut for businesses. Most analysist agreed that a fiscal stimulus should be “timely,
targeted and temporary” to be effective.

3.Lower employment

The unemployment rate is the percentage of the labor force that is unemployed.
This is a lagging indicator, which means that it usually rises or falls in response to
changing economic conditions, rather than anticipating them. When the economy
is in bad shape and jobs are scarce, the unemployment rate is expected to rise.
When the economy is growing at a rapid pace and jobs are relatively abundant, it is
expected to decline.
The unemployment rate across the country jumped nearly 10% after the subprime
lending crisis, but has trended downward since then. However, unemployment
prices in some states continue to move better than the national average. At the end
of January 2020, the price of Alaska goes to 6.1%, the price of D.C goes to 5.3%,
while the price of Mississippi goes to 5.7%. However, the price of unemployment
nationwide is expected to rise significantly as a percentage until 2030.Although
this no longer looks like a good deal, local and national unemployment could also
jump.

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LEARNINGS FROM THE CASE

 The artificially created demand is not for the growth of an organization or an

economy. Sooner or later it returns to its original place and creates many
interruptions.
 Innovation and progressive strategy are essential in today's competitive
environment. However, regular assessment and an alternative strategy should also
be favored; otherwise, it results negative growth.
 Finance is blood. It must be researched, managed and used in an efficient and
prudent manner. The U S economy has raised a significant amount of money, but
the greed of the bank has led to low use.
 To lead an organization effectively and progressively, strong leadership is a
prerequisite. The organizational structure plays the most important role in
achieving this goal. US political aggression against the 9/11 terrorist attack ignored
the economy, causing crisis and questioning future growth.
 Autonomous organizations should not be influenced by any situation and that is
exactly what happened at the Federal Bank, which has taken many accommodating
measures for the benefit of greedy bankers, putting aside the real need of the
sector.
 Future uncertainty should always be kept in mind when planning and
implementing any growth strategy. Overlooking can cause lots of damage. U S was
too much involved in its previous crisis, i.e. the dot-com bubble and the 9/11
attacks, and overlooked the possibilities of another crisis, which unfortunately
occurred in 2008.

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